What is leverage in trading?

¿En qué consiste el apalancamiento en trading?
5 min read

When using complex financial products, it is very important to understand the risks involved in the investment. 

As the old adage goes, ‘don’t invest more than you can afford to lose’…. That’s why today we want to show you a tactic that can help you get more profit margins. Let’s find out what leverage in trading is all about. 

What does ‘Leverage’ mean?

Leverage refers to borrowed funds that increase the size of a trader’s position and its exposure to the market and, therefore, its profitability.

That is, by using leverage, you can invest a smaller amount of funds in order to open a larger position in the market. 

In trading, leverage is generally presented as a ratio, for example 1:2. 

Let’s see what this ratio means.

If you deposit €1 in your account, you can open operations worth €2. 

Let’s take another example: with leverage/ratio of 1:5, if you open a position of 10,000 euros, only one fifth of that amount (2,000 euros) represents your own money, since you have borrowed the remaining 8,000 euros. If this operation generates a yield of 5% (500 euros), your account balance could increase by up to 25% (2,500 euros). 

Simply put, leverage increases your earning potential, but it also increases your exposure to risk. 

Imagine that the result of the operation in the above example was a 5% loss instead of a gain. In this case you would have lost 25% of your account balance.

When to use leverage?

Similarly, in the stock market, when you don’t have enough money to buy stocks, leverage can be a practical option.

Suppose we want to buy a stock with a minimum lot size of €500, but we only have €100. We could use leverage to buy the same shares with less capital.

Ex: Leverage 5X: €100 x 5 = €500. Therefore, we can buy €500 worth of shares with only €100.

Options trading, futures contracts and buying on margin are examples of leveraged trading.

When used correctly, leverage can be attractive as it can bring large profits but it is also very risky.

The greater the amount of leverage over capital you apply, the greater the risk you run. 

Therefore, it is important to monitor positions, apply a stop loss and use other market orders to avoid large-scale losses. Also, remember that in the trading universe it is very important for traders to keep their emotions under control in this area.

What is leverage in cryptocurrency trading?

¿Què es el apalancamiento en el Trading de criptomonedas?

Bitcoin is one of the best investments of the decade, as its price is rising steadily. 

So, if you found the concept of leverage interesting, the good news is that you can also apply it to the cryptocurrency markets. In other words, using borrowed capital to make a cryptocurrency transaction also has its benefits.

In the case of cryptos, you can borrow funds from other users or an exchange and pay interest on those loans.

In the same way, you can act as a lender and lend other users your cryptocurrencies in exchange for interest and earn profits.

Therefore, leverage in Bitcoin or other cryptocurrency trading allows you to control larger positions and earn more profit. 

If you decide to trade cryptoassets using leverage, you do not need to own any particular cryptocurrency. 

For example, you can make a potential profit by predicting the direction of the BTC price. When you open a buy or sell position, a specific amount of funds from your account balance will be used as margin for the specific position. The specific amount of funds is known as ‘margin’.

For example, a leverage of 25:1 means that for every dollar the trader bets on stocks, he can trade $25 (this is known as a 4% margin trade).

CONCLUSIONS

Always remember that, as a trader, you should be aware that leveraged trading may involve risks and losses of your funds. Therefore, we advise you to use leverage within its logical limits, i.e. only when the advantage is clear, as its effect on both profits and losses can be magnified. 

Finally, if you are a beginner, when trading on a trading platform, remember to always use a demo account to trade cryptocurrencies before depositing real funds.

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